Dollar Weakens Modestly as New Week Begins

May 24, 2021
  • Markets have to start pricing in a slightly more hawkish Fed going forward; stronger U.S. data ahead should feed into further tapering talk at the June 15-16 FOMC meeting; Mexico reports mid-May CPI; the prospect of left turn in Brazil’s politics is rising
  • Political tensions in Eastern Europe are rising after Belarus grounded a Ryanair flight to arrest a journalist critical of the government; ECB asset purchases for the week ending May 21 will be reported
  • Concerns about China’s financial system are back in the spotlight; iron ore is falling off a cliff on more concerns about regulatory moves in China; not surprisingly, AUD is underperforming today and over the past week

The dollar is coming under some modest pressure as the week begins. Given the lack of any major U.S. data reports early in the week, upward momentum may be difficult to maintain near-term. However, plentiful Fed speakers ahead and key data towards the end of the week should prevent markets from getting too bearish on the greenback. DXY is trading back below 90 after Friday’s bounce. The euro is trading back above $1.22 while sterling is trading heavy just above $1.41 after testing its 2021 high near $1.4235 Friday. USD/JPY remain heavy and continues to trade just below 109. Until we see stronger U.S. data and higher U.S. rates (both real and nominal), the greenback is likely to remain under modest pressure.

AMERICAS

Markets have to start pricing in a slightly more hawkish Fed going forward. The April FOMC minutes show that the Fed has started talking about talking about tapering. Kaplan has turned out to be the most hawkish at the Fed in recent weeks. Last week, he said that labor markets may be tighter than what the headline stats show and reiterated that tapering talk should happen sooner rather than later. That’s nothing new. However, the tone of other Fed official has clearly shifted and that has helped push U.S. breakeven inflation rates lower. The 10-year breakeven is around 2.45% and the 5-yrear is around 2.64%, both off their recent highs of 2.59% and 2.82%, respectively.

Stronger U.S. data ahead should feed into further tapering talk at the June 15-16 FOMC meeting. Chicago PMI and core PCE data Friday are the key data points this week, with upside risks seen to both in light of other readings already seen. Last week, more and more Fed officials seem to be embracing the notion of tapering coming sooner rather than later. This week’s Fed speakers will be closely watched. Brainard, Mester, Bostic, and George speak today. Recall that in the March 16-17 Dot Plots, four FOMC members saw the first hike in 2022. The upcoming June Dot Plots will be very interesting, and we suspect that more than four will see the first hike coming in 2022. Yet we are disappointed that the U.S. 10-year yield begins this week at 1.62%, near the bottom of recent ranges. However, the bigger drop in inflation breakevens has pushed U.S. real yields higher, with the real 10-year at -0.82%, the highest since April 30. A continued rise should help the dollar get more traction. April Chicago Fed National Activity Index (1.10 expected) is the only U.S. data to be reported today.

Mexico reports mid-May CPI. Headline inflation is expected at 5.66% y/y vs. 6.05% in mid-April. If so, it would still be well above the 2-4% target range. Last week, Deputy Governor Irene Espinosa said there’s no room for further easing interest rate cuts, and that the bank may eventually need to start withdrawing stimulus if inflation pressures remain elevated. The bank voted unanimously on May 13 to keep rates steady 4%. April trade and Q1 current account data will be reported Tuesday. Banco de Mexico minutes will be released Thursday and will be watched closely for signs that other MPC members are following Espinosa’s more hawkish line.

The prospect of a left turn in Brazil’s politics is rising. Last Friday, a poll showed that former President Lula could beat incumbent Bolsonaro in a runoff-election 45% to 37% in the October 2022 race. Needless to say, this would be a huge change for the country, but we think it’s too early to trade this risk. A lot can and will still happen before then. For the time being ,markets are likely to remain focused on more immediate drives such as the outlook for the pandemic in the country, the central bank rate cycle, commodity prices, and the overall dollar outlook. That said, the news jolted BRL on Friday with a 1.6% decline against the dollar, far worse than its EM peers.

EUROPE/MIDDLE EAST/AFRICA

Political tensions in Eastern Europe are rising after Belarus grounded a Ryanair flight to arrest a journalist critical of the government. Journalist Roman Pratasevich had been an outspoken critic of President Alexander Lukashenko during the protests in Belarus. The incident is particularly disturbing for the EU, as the flight was going from Greece to Lithuania, two member states. These would be on top of sanctions that were already being discussed prior to the incident. Foreign leaders have quickly come out to condemn the action and sanctions are likely soon. EU leaders meet today to discuss potential actions, which include sanctions against individuals and entities, suspending all flights by EU airlines over Belarus, banning Belarus carrier Belavia from landing at airports in the EU, and suspending all transit, including ground travel, between Belarus and the EU. . Predictably, the country’s assets sold off with yields on the 2031 USD-denominated bond rising 56 bp to 7.70%.

ECB asset purchases for the week ending May 21 will be reported. Net purchases were EUR19.0 bln for the week ending May 14 and EUR16.3 bln for the week ending May 7. Due to fairly high redemption, gross purchases were EUR23.2 bln for the week ending May 14 and EUR24.6 bln for the week ending May 7. We know this accelerated pace will be reviewed at the June 10 ECB meeting. If yields continue to rise, then the accelerated pace is likely to be extended into Q3, which would be a dovish sign. Lagarde’s comments last Friday signaling steady policy helped weaken the euro and push eurozone yields lower, especially Italian BTPs. AS we have written before, the combination of a strong euro and rising yields is something that ECB policymakers want to avoid at this stage of the recovery, especially with no fiscal stimulus seen yet from the recovery fund.

ASIA

Concerns about China’s financial system are back in the spotlight. Major asset manager Huarong continues to face concerns that it won’t be able to make payments, despite the firm’s insistence that it can repay its debt. The company (along with three others) was set up to help managed state-owned distressed debt, but recent local media reports claim that it would need restructuring itself. Huarong’s debt has garnered significant foreign investors demand, in part based on the (now questionable) presumption of an implicit guarantee given its links to the government. That said, Caixin wrote that Huarong is “nowhere near” defaulting on its more than $20 bln in offshore debt, adding that neither the Ministry of Finance nor Chinese regulators would allow this. Consistent with the risk of an eventual restructuring, much of the price action has been seen on the perpetual bond, now yielding nearly 50%, compared to about 2% in early April.

COMMODITIES AND ALTERNATIVE INVESTMENTS

Iron ore is falling off a cliff on more concerns about regulatory moves in China. Officials remain outspoken about going after speculation and hording of commodities, which they view as driving higher the prices of vital raw materials. The NDRC released a statement saying it would show “zero tolerance” for monopolistic behavior in the commodity space. Iron ore, where most of the tension has been, is down nearly 20% from its highs earlier in the month. Copper and agricultural commodity prices have also come off, but by far less.

Not surprisingly, AUD is underperforming today and over the past week. It has been trading largely within a tight .77-.78 range over that time and remains well below the February 25 high near .80 even as the euro and sterling are making new highs for this move against the dollar. A break below the .7670 area would set up a test of the April 1 low near .7530.

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